Globalization and American Wages

[Joanne98]

http://www.epi.org/content.cfm/bp196
Globalization and American Wages
Today and Tomorrow

by L. Josh Bivens

The continuing integration of the rich United States with a far poorer global economy has provoked much anxiety among American workers. Because it is well-known that basic economic theory predicts that global integration leads to gains for all nations, this anxiety is often treated as a political puzzle. A once again fashionable explanation for this puzzle is that globalization’s benefits are huge but diffuse (primarily, lower prices for imported goods), while its costs are small but concentrated (workers displaced by imports); hence, the gains are hard to see, but the losses are all too visible.1

This Briefing Paper reexamines what conventional economics actually predicts about the effects of integrating the rich United States and poor global economies. Contrary to popular rhetoric, there is no puzzle to be explained: conventional economic theory argues that American workers will indeed be harmed by this integration—and their anxiety is well-founded.

The paper also provides rough empirical estimates of integration’s effect on American wages and inequality. Lastly, it uses some prominent forecasts about the future potential reach of service-sector offshoring to make a very rough guess as to the future wage implications of these forecasts.

The key findings indicate:

• In 2006, the impact of trade flows increased the inequality of earnings by roughly 7%, with the resulting loss to a representative household (two earners making the median wage and working the average amount of (household) hours each year) reaching more than $2,000. This amount rivals the entire annual federal income tax bill paid by this household.

• Over the next 10-20 years, if some prominent forecasts of the reach of service-sector offshoring hold true, and, if current patterns of trade roughly characterize this offshoring, then globalization could essentially erase all wage gains made since 1979 by workers without a four-year college degree.

What economic theory actually teaches about globalization and wages

When people argue that economics teaches that liberalizing trade is a “win-win” proposition, what they mean (whether they know it or not) is that trade is “win-win” between countries. The great insight of comparative advantage, the cornerstone of international economics, is that even when one country can produce everything more cheaply than its trading partners, trade still provides benefits to both nations.

An important caveat, however, notes that even as globalization raises national income, it can still reduce the incomes of most workers. Global integration has at least two potential impacts on American wages. First, workers employed in industries directly in competition with low-cost imports from abroad can expect to see immediate job dislocation and/or downward wage pressures. Second, as relative prices change across industries, the return to factors of production, including different kinds of labor inputs, can be expected to change as well. A simple example can capture the essential insights of this second impact (which is almost surely the less intuitive one).

Start with a couple of assumptions about the U.S. economy. Say that the labor force of the U.S. can be divided into workers (those who supply labor) and professionals (those who also supply additional skills, capital, and credentials). Assume further that there are just two sectors in the U.S. economy, call them apparel and aircraft. Workers and professionals can work in either sector. If this sounds unrealistic, remember that this is a story about what matters over a reasonably long period of time. While people obviously do not lose an apparel job on Monday and begin working at Boeing on Tuesday, in the relatively fluid American economy, people do switch across many economic sectors throughout their working lives.

Lastly, assume that producing each $1 of apparel takes a ratio of workers to professionals twice as high as producing each $1 of aircraft—that is, apparel is the more labor-intensive business.

Now, say that falling trade costs (a tariff cut for example) reduces the price of apparel imports. Since domestic producers must compete with imports, this means that the price of domestically produced apparel falls as well. Fewer domestic producers are then willing to make apparel, as falling prices make this a less attractive business. Imports rise to replace this lost domestic production. Lastly, and importantly, aircraft exports rise as domestic investment once ploughed into apparel looks for new opportunities and as U.S. trading partners’ greater specialization in apparel leads them to demand more aircraft from the U.S.

As domestic apparel production contracts, too many workers are displaced to be absorbed in the expanding aircraft sector at the going wage for workers. Remember that the ratio of workers to professionals was higher in the apparel sector, so each $1 of apparel production abandoned releases “too many” workers relative to professionals to be absorbed by a $1 increase in aircraft production. Even after absorbing all of the professionals released from the declining apparel sector, there will still be many former apparel workers not finding work in the aircraft sector at the going wage.

If these unemployed workers want a job, they must agree to a wage cut. Further, it is not just the unemployed labor that takes a wage cut—it is all workers economy-wide. Any incumbent worker in either aircraft or apparel not agreeing to this wage cut would be replaced with those unemployed workers. The process works in reverse for professionals, with the apparel sector not shedding enough of them at the going professional wage in order to meet the demands of the expanding aircraft sector. This imbalance bids up professional wages.

Essentially, by changing the structure of what an economy produces, globalization changes the relative demand for different kinds of labor, skill, and capital. In the example above, globalization pushed the domestic economy into demanding fewer workers and more professionals by tilting the structure of domestic production away from labor-intensive apparel and towards professional-intensive aircraft.

The most well-known outcome of this process is that the gross gains for professionals outweigh the gross losses of workers, hence the national economy sees net gains from trade.2 It is these net gains (which are much smaller than either the gross gains or gross losses) that constitute the argument in favor of global integration. However, it is (obviously) the gross losses that worry many workers about globalization, and this fear is utterly rational in light of economic theory.3

It should be noted that the (slim) majority of U.S. imports come from countries that are not that much poorer than the United States. This sort of trade (call it rich/rich trade)
http://www.epi.org/content.cfm/bp196

[Demeter]

1. The Dollar Droppping Like a Stone Will Guarantee Equalization of Wages

[Joanne98]

2. Yep

[Manifestor_of_Light]

3. It is a myth that only the unskilled lose their jobs.

People in service industries with advanced degrees have lost jobs by the thousands too.

[Vincardog]

4. Not to mention previously well paid IT jobs are now non existent

[Turbineguy]

5. Wage job holders compete

Senior corporate management types and politicians do not.